The difficult and painful commodity world

The commodity complex continues to hurt many investors directly and indirectly. We have written about commodities and the issues with many of the products in the past and most recently about the indirect pain in the high yield market with regard to Oil and Gas exploration companies.

Broad based commodity funds and ETFs have lost 13% or more over the last year in a very tough environment for many commodities such as oil, gold, wheat and base metals such as aluminum. Among other reasons, basic oversupply and lower demand have driven prices down. The Powershares ETF DBC which represents futures contracts in major commodities such as Oil, Gold, Wheat and Aluminum is down and has not provided the inflation protection or the diversification benefits that many advisers have hoped for.

We decided to take a look at the underlying commodities to determine if the futures curves in each are in a state of contango or backwardation. As a review, contango is not an enviable state while backwardation allows for the potential to profit. The key question is whether or not the manager or instrument used has the ability to navigate the futures curve adeptly.

It is important as wealth can be eroded by buying contracts that are part of a futures curve that is in contango and after examining some of the curves for energy and gold at least, there is reason to be concerned as at least a few of these areas display contango.

We recommend that your investment committee take a serious look at the methodology that your ETF or active mutual fund manager employs as a poor process can cause wealth destroying damage. If you would like some assistance in this due diligence project, Zenith would be happy to help out and provide our insight.